If
You Try to Pay Off a Commercial Mortgage Loan Your Penalty Might
Be 20% of the Balance!

Most
commercial mortgage lenders making fixed rate commercial mortgage loans
charge a prepayment penalty. The reason why is because the investors
who buy commercial mortgage backed securities (CMBS) want a certain
yield that is locked in. Why? Imagine you are a pension plan making
actuarial projections to be sure you have enough money to pay your
retirees. You need to know that you will earn a certain amount of interest.
This is why you buy commercial mortgage backed securities.

The
most common form of prepayment penalty is a defeasance formula. The
legal definition of defeasance is, "A provision in an instrument
that nullifies it if certain acts are performed."

When
a borrower wants to pay off a fixed rate commercial mortgage loan,
he must perform an act; i.e., he must give to the lender a bundle of
U.S. Treasuries that provides the lender with the same stream of interest
payments and the same balloon payment as the original mortgage.

Buying
and assembling these U.S. Treasuries is immensely expensive, often
on the order of 15% to 20% - and sometimes 25% - of the principal balance
on the loan! Watch out for loans with a defeasance prepayment penalty.